SEC Rule 10b-5
The SEC promulgated Rule 10b-5 in 1943, pursuant to authority granted by Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act"). Rule 10b-5 has been the general antifraud rule applicable to "the purchase or sale of any security." The rule prohibits material ommission or misleading statements, whether oral or written. The latter may be in a formal prospectus or merger agreement, or in a handwritten sales pitch. The rule is a true catchall. Even though an issuer or broker-dealer has complied with an SEC or self-regulatory organization form calling for item-and-answer disclosure, Rule 10b-5 nonetheless applies and requries disclosure of any remaining material information. The Supreme Court has also held that securities law remedies, and in particular Rule 10b-5, are cumulative rather than alternative. Thus, a plaintiff alleging an omission or misleading statement in a formal prospectus filed with the SEC may pursue both the implied remedy under Rule 10b-5 and any applicable express remedy as well, such as that under Securities Exchange Act Section 11. Rule 10b-5 jurisdictional means are very broad, prohibiting material misstatements of omission "by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange." No requirement exists that the transaction itself be in interstate commerce. The use of the mails, telephone or cyber-facilities in accomplishing the transaction will satisfy the jurisdictional means. Because the rule prohibits conduct in connection with the purchase or sale of "any" security, the rule does not limit its scope to securirites of publicly held corporation. The upshot of those two observatiions is that a misrepresentation in a wholly intrastate trasnaction, in the securities of a small or closely held coropration, may be actionable in federal court under SEC Rule 10b-5. Insider trading cases are a subset of a set of Rule 10b-5 cases, namely cases of silence, rather than misstatement, by a person in a fiduciary or similar relationship. Elements of a cause of action under Rule 10b-5 *implication of private rights of action to sue for violation of the rules *Standing to sue *materiality *pleading state of mind *The required state of mind (also known as scienter) *Reliance (transaction causation ) *Causation (loss causation ) *Remedies for violation of some of the rules Secondary Liability for Disclosure Violations Freezeout In a freezeout, a SEC Rule 10b-5 cause of action may arise for the minority shareholders if there is a lack of full disclosure that forces the minority shareholders to exchagne the merger (that is, sell) their share. In Santa Fe v. Green, minority shareholders of a Delaware corporation were forzen out in a short form merger and offered $150 cash for hteir shares (the physical assets were appraised at $640 per share). With a short form merger, a control group owning mroe than 90% of the shares could effectuate the merger without a sharheolder vote or prior notice. Under Delaware law, the shareholder could have sought an appraisal but at the time appraisal was usually avoided given its limitations and the new appraisal created in Weinberger had not yet been established. Sine teh case was pre-Singer, it was assumed that an appraisal was the only state remedy. Minroity sharehodler instead sought a federal remedy hoping for greater dmaages and relief. The shareholders tried to claim a federal cause of action under SEC rule 10b-5. *They argued that a remedy existed under the RUle because there was fraud resulting from the gross undervaluation or a breach of fiduciary duty in treating the minority unfairly by merger with no business purpose and without prior notice. Because there was this alleged fraud in the sale of securities (the forced freezeout merger), they claimed a federal cause of actionunder SEC Rule 10b-5 which explicitly prohibits fraud. *The Supreme Court in Santa Fe found no fraud under the Rule since there was no lack of disclosure by the control group. There was also no prior notice requirement for short form mergers under Delaware law and thus no deception. The Court clearly limited the use of Rule 10b-5 to caes invovlign deceit, holding that causes of action based on breach of fiduciary duty without a disclosure claim belong in state court. The Court looked to the statutory lanague of Section 10(b) (as opposed to the RUle issued by teh SEC pursuant to the statute) which did not use hte word "fraud" but use the words "manipulative" and "deceptive." The words of hte statute contorl how the Rule will be interpreted. Manipulation was viewed as a term of art to deal with pratices that articfically affect market actiivty and are not disclosured which was not invovledi in the caes. Depception invovles a lakc of full disclosure and or misrepresentation. This use of particular language in Section 10(b) indicated Congressional intent for the statute , adn the Rule issued purusant to that statute, to requrie some deception in the purcahse or sale of securities in order ot be covered by teh law. Part 4 of the Court's opinion, which was dictum, stressed the Court's reluctance to "federalize the susbtantial poriton of the law of corproaiton that deals iwth transactions in securities, particularly where established state poliicies of corporate regualtion would be overridden." THis suggested that broadly speaking, even if there was fiducairy duty involving a lack of disclsoure, i.e., a deceit, in the pruchase or sale of securities, there should be no Rule 10b-5 cause of action because state corporate law dealt with fiduciary duty issues not federal securities law. Although part 4 of Green suggested that most fiduciary duty claims even with deceit should be in state court and not in federal, many lower courts have ignored the broad implications of Part 4. Those courts would allow a SEC Rule 10b-5 cause of action may arise in a freezeout not involving a short form merger if the lack of disclosure had an effect on the shareholders. For example, the deceit precluded the minority shareholder from exercising their right to seek an appraisal or from seeking equitable relief in state court or was material when a majority of the minority sharehodler were needed to authoritze the merger. Federal securities law continues to be important in regulating freezeouts, but only in the context of a deceit invovling a material lack of full disclosure.